Turkey Bank Hazards Revealed in CEO Shoe Boxes With Cash

Turkish Prime Minister Recep Tayyip Erdogan greets supporters in Ankara, on March 31, 2014. Even after Erdogan’s party maintained control in local elections over the weekend, state-owned banks face the prospect of a weakening economy, surging bad debt and a repeat of the 2001 financial crisis when they lost $28 billion and were bailed out by the government. Photographer: Kayhan Ozer/Anadolu Agency via Getty Images

April 1 (Bloomberg) -- When Turkish police raided the
Istanbul home of Suleyman Aslan in December, they found $4.5
million stashed in three shoe boxes and hidden in bookshelves.

Aslan, then chief executive officer of the country’s
second-largest state-owned bank, said in court that the money
was donations collected for his alma mater in central Turkey and
to help build a university in Macedonia. When asked why the
funds weren’t deposited at the bank he ran, he said that would
mean declaring their origin and registering them officially,
according to accounts of his testimony in local newspapers.

Dozens of phone conversations purported to be police
wiretaps and leaked over the Internet in recent weeks instead
paint a portrait of a banker helping a businessman smuggle gold
and transfer hundreds of millions of dollars to Iran, evading
U.S. sanctions. Surveillance photos said to be taken by police
show similar boxes being delivered to Aslan’s home. The money
was intended as bribes to ensure his cooperation, police allege.

In a separate investigation, Huseyin Aydin, CEO of Turkey’s
largest government-owned bank, was overheard by police approving
loans to businessmen who said they were under orders from Prime
Minister Recep Tayyip Erdogan to buy a media company. Aydin
hasn’t been charged with wrongdoing.

Even after Erdogan’s party maintained control in local
elections over the weekend, state-owned banks face the prospect
of a weakening economy, surging bad debt and a repeat of the
2001 financial crisis when they lost $28 billion and were bailed
out by the government.

‘Badly Mismanaged’

“What has come out in recent months is definitely raising
concerns that maybe we’re back to the old days when these
institutions were badly mismanaged,” said Alyssa Grzelak, a
Washington-based senior economist for banking risk at research
firm IHS Inc. “After the 2001 crisis, they were supposed to be
cleaned up and no longer doing the bidding of politicians, but
that seems to have been reversed.”

The ruling party’s candidates for municipal governments won
45 percent of the vote nationwide, according to unofficial
results reported by CNN Turk television. While that put
Erdogan’s party ahead of all opposition groups, it’s less than
the 50 percent it received in the 2011 general election to win a
third consecutive majority in parliament. The results shouldn’t
comfort Erdogan, who faces elections for president in August and
parliament in 2015, because the impact of a slowing economy has
yet to be felt by voters, according to William Jackson, an
economist at Capital Economics Ltd. in London.

‘Political Uncertainty’

“The sharp slowdown in economic activity that we’re
expecting this year will hurt support for the ruling party in
August and next year,” Jackson said. “Economic growth always
feeds into election results, even if there’s a lag sometimes.
The weekend’s result might look good for Erdogan, but it
definitely doesn’t mean the end of political uncertainty.”

Protesters blaming the government for rigging election
results clashed with police in the capital Ankara today. Police
used tear gas to disperse crowds gathered in front of the
national election authority, NTV television reported.
Anti-government demonstrations have erupted around the country
in the past 11 months. Dissidents accuse Erdogan of having
become autocratic and disregarding democracy.

Credit Binge

Aslan, born in 1970, and Aydin, born in 1959, rose to the
top of their respective banks in the 11 years since Erdogan
became prime minister. While each has more than two decades of
banking experience, the top executives of Turkey’s state-owned
lenders have long been political appointees who help carry out
government policies.

State-owned banks, which accounted for 26 percent of total
lending in 2013, helped fuel a credit binge in Turkey that
enabled businesses run by Erdogan supporters to win lucrative
infrastructure contracts, beating the country’s largest
companies and sometimes global firms in bidding wars.

While all Turkish banks have taken part in the credit boom,
government-controlled lenders may have played a more prominent
role, according to transcripts of phone calls and police records
released on Twitter and YouTube.

Turkiye Halk Bankasi AS, the Istanbul-based bank Aslan ran
until his arrest in December, expanded its assets by 30 percent
last year to $66 billion, twice what they were in 2010. Another
government-controlled lender, Turkiye Vakiflar Bankasi TAO,
increased its assets 29 percent in 2013 compared with an average
of 26 percent for all Turkish banks. Ankara-based TC Ziraat
Bankasi AS, led by Aydin, rose 27 percent.

Leaked Recordings

In leaked recordings of phone calls allegedly made in
October, Aydin can be heard talking to businessmen who say they
have been ordered by Erdogan to buy Turkey’s Sabah newspaper and
ATV television network. The calls were taped as part of a string
of investigations that came to light on Dec. 17, when scores of
people tied to Erdogan’s government were arrested or detained on
charges including gold-smuggling, bribery and bid-rigging.

Transcripts of the conversations along with thousands of
pages of documents have been leaked by unidentified people since
the government dismissed and replaced police chiefs and
prosecutors involved in the investigation, which Erdogan has
said were part of an effort to undermine him in advance of the
elections. While each sound recording is labeled and subtitled,
the police reports include transcripts of conversations that
haven’t been released and couldn’t independently be verified.

Debt Loads

The money-losing media companies had been put up for sale
by an Erdogan ally in financial difficulty. Because the buyer
couldn’t borrow the purchase price in excess of $500 million on
his own, five construction firms formed a pool to help with the
acquisition. Aydin arranged loans of $100 million to each firm,
bypassing internal credit limits for some, overlooking their
already heavy debt loads and ignoring collateral requirements,
according to the recordings and transcripts.

“I’m starting these loans with a two-year maturity so
nobody gets suspicious,” Aydin told one of the businessmen in a
conversation purportedly taped by police. “But I will turn that
to five years, seven years, don’t you worry about that.”

Aslan allegedly accommodated the gold-smuggling business of
Iranian-born businessman Riza Sarraf, according to phone
conversations leaked in recent weeks. After Sarraf complained
that some of Aslan’s subordinates objected to documents
submitted in relation to fund transfers, Aslan told him he would
tell his associates to be more lenient.

Other Wiretaps

“I’ll go over everything and tell them there will be no
further demand for additional documents, and I’ll even reduce
the initial requirements,” Aslan said in a July telephone call
with a person police identified as Sarraf.

Other wiretaps reveal the involvement of three ministers
and their approval of the bank’s actions.

Spokesmen at Halkbank and Ziraat declined to comment for
this article. Aslan, who was released from prison after about
two months, and Aydin weren’t available to be interviewed, their
respective banks said. The court returned the money to Aslan,
who remained on Halkbank’s board until yesterday.

Halkbank has said all its money transfers to Iran have been
legal because there was no international ban on trading gold
with the country until July and the company stopped transferring
funds for that purpose after the sanctions went into effect.

Cheap Loans

In a February television interview Aydin defended Ziraat’s
lending to the five companies as legal and within bank
procedures. Two of the firms at the center of the disputed
purchase are among Turkey’s most successful and have borrowed
from other banks, Aydin told Bloomberg HT, a broadcast
partnership of Bloomberg News and an Istanbul media group.

He said talks with clients about the pricing and maturity
of loans, like those captured on the wiretaps, are normal for a
bank CEO.

Turkey’s state-run banks have been used before to win
political support. In the 1990s, their main business of making
cheap loans to farmers and small companies consistently lost
money because the banks charged less interest than what they
paid for deposits. The institutions ran up losses that equaled
14 percent of the nation’s gross domestic product at the time.

In December 2000, the state banks’ hunger for funds led to
an unprecedented spike in interbank lending rates, which reached
1,950 percent at one point. The system collapsed two months
later, when the Turkish currency’s peg to the dollar and the
euro could no longer be sustained.

Majority Control

After the 2001 crisis, when the economy shrank by almost 10
percent, Turkey promised the International Monetary Fund it
would sell all state banks within a few years. Erdogan, while he
didn’t stick to the promise, continued efforts to make the
lenders profitable. Halkbank and Vakifbank sold shares to the
public, forcing them to disclose more financial information,
even as the government maintained majority control.

Before the voice recordings started showing up on the
Internet in December, analysts such as Grzelak and investors
including BlackRock Inc. didn’t express concerns that the state
banks were in trouble. Profits were rising, and bad-loan ratios
were low. Because other government-controlled firms are required
to keep their cash in non-interest-bearing accounts at the three
state lenders, the free money boosts profitability.

BlackRock built sizable stakes in Halkbank and Vakifbank.
The New York-based company, the world’s largest asset manager,
is the second-biggest shareholder in Halkbank, after the
government, with a 5 percent stake. It added to that position in
January, saying price declines made the shares cheaper. Halkbank
and Vakifbank shares dropped more than 30 percent after raids on
the homes of dozens of politically connected individuals in
December and were down almost 20 percent as of yesterday,
compared with a 7 percent decline for the Borsa Istanbul Banks
Sector Index, which includes the state lenders.

A spokesman for BlackRock in London declined to comment.

Parliamentary Audit

There were earlier warning signs that lending decisions
were being influenced by political connections. In July, a
parliamentary audit of Halkbank leaked to local newspapers and
also obtained by Bloomberg News highlighted the firm’s $450
million loan to a company owned by Sebahattin Yildiz, an Erdogan
supporter in financial trouble.

The bank’s exposure to Yildizlar SSS Holding rose, even
though the lender knew the Ankara-based mining and ceramics firm
was in default on other obligations and that its collateral for
some loans was less than purported, according to the audit. In
one instance, the collateral claimed by the firm to be $130
million was worth $8 million, the audit showed.

Energy Regulator

Halkbank responded to the leak by saying that Yildizlar was
paying its debt on time and there wasn’t any reason for panic. A
few weeks later, the nation’s energy regulator seized a power-distribution network run by the company because it was behind on
payments for about $100 million of electricity. The bank still
hasn’t categorized the loans as nonperforming. In a February
statement, Halkbank said the collateral from the company was
fairly valued.

State-owned lenders including Halkbank often issue new
loans to troubled borrowers so they can avoid reporting them as
restructured, according to two bankers with knowledge of the
practice. Regular restructurings -- extending the maturity of a
loan or reducing the interest rate -- have to be reported in
company filings.

At Turkiye Is Bankasi AS, Turkey’s largest non-government
bank, restructured loans have multiplied sixfold in the past
three years. They have quintupled at Garanti Bankasi AS, the No.
2 lender. State-owned banks’ undisclosed restructurings probably
exceed those rates of deterioration, the bankers said.

Default Rates

Restructured loans have higher rates of default and would
be the first to fail if the economy turns sour, according to
Mete Yuksel, head of research at TEB Invest, an Istanbul-based
brokerage. While disclosed restructurings at non-state banks
have been rising in recent quarters, it’s difficult to know how
much may be hidden, he said.

“NPL ratios can rise significantly systemwide if the
economy doesn’t recover toward the end of this year,” Yuksel
said, referring to nonperforming loans.

The Turkish economy is facing headwinds. Last year, the
prospect of an end to the U.S. Federal Reserve’s easy-money
policies sparked an outflow of funds from emerging markets and
hurt the currency. The lira’s slide accelerated after the
December raids, which led to the arrests of the sons of three
government ministers and revealed an internal struggle within
Erdogan’s coalition. The currency lost one-quarter of its value
in the 12 months through January, when the central bank doubled
interest rates to 10 percent to prevent further outflows. It has
stopped falling since.

Slowing Economy

The median growth estimate of economists surveyed by
Bloomberg News is 2.3 percent this year, down from a 4 percent
expansion in 2013.

Some economists, including Jackson of Capital Economics,
predict a recession. The higher cost of imports resulting from
the devalued currency and increased borrowing costs will hamper
growth, according to Jackson.

Erdogan, who acknowledged the veracity of some recordings,
has tied them to a conspiracy by a faction of his governing
party that has turned against him. His government swiftly
reassigned judges, prosecutors and police chiefs in January and
February to muffle the investigations. Since then, all suspects
arrested in December have been released from custody.

Even if courts refuse to take action, tapes of wiretapped
calls and police reports keep finding their way to the Internet.
Last month, Erdogan banned access to the popular microblogging
website Twitter and the video website YouTube to prevent new
leaks from reaching the public.

Doesn’t Care

Pro-government media portray a nation that doesn’t care
about the revelations and continues to support its leader. While
thousands protest against corruption and eroding democracy in
the big cities, others attend campaign rallies to hear Erdogan.

Much of the support is the result of improvement in
Turkey’s economic well-being. Income per capita has doubled
since Erdogan came to power in 2003. While that was fueled at
first by structural changes and rising productivity, growth in
the last few years has been dependent on surging private debt.
Corporate and consumer borrowing jumped to 67 percent of GDP in
2013 from 33 percent in 2008.

Almost 90 percent of the country’s corporate debt has been
accumulated by closely held nonfinancial companies without any
public disclosure of their balance sheets, ownership structures
or other basic information, according to data compiled by Burgan
Yatirim Menkul Degerler, an Istanbul-based brokerage. Many of
those, including Yildizlar and the five construction firms that
bought Sabah and ATV, are companies that were established or
came to prominence since Erdogan came to power.

Heavily Exposed

They have been winning billion-dollar infrastructure
contracts for airports, roads and bridges, buying state assets
and racking up debt. While not all of this has been financed by
government-run banks, recent revelations have increased the
probability that they’re more heavily exposed.

“We know so little about these new firms that have grown
so fast thanks to their political connections,” said Nergis
Kasabali, Burgan’s head of research. “We don’t know how highly
levered they are. The higher the firm’s leverage, the easier
they’ll fall apart and start defaulting on their loans during an
economic downturn.”

Almost half of the outstanding corporate debt is
denominated in foreign currencies, which increases the risk of
failures. While some borrowers are exporters, many rely on
domestic consumption. The lira’s decline has eroded consumers’
purchasing power and will dent those companies’ sales, making it
harder to pay back loans in dollar or euros.

Legal Turmoil

Three Turkish bank executives point to the halt in new
projects as a harbinger of what’s to come. The five firms that
bought the media company had won a tender to build and run a
third airport for Istanbul, offering to pay the government $30
billion for a 25-year lease. The political and legal turmoil,
combined with cost overruns before excavation began, have thrown
the project’s financing into limbo, said the bankers, who have
been involved in the airport-funding effort.

If Erdogan’s power wanes, defaults by some politically
connected companies could follow, said the bank executives, who
asked not to be named because of fear of reprisal. That would
probably lead to increased cover-ups, which could be sustained
until either Erdogan is voted out of office in 2015 or the
losses spook creditors enough to cause a run on the banks, as
they did in 2000, according to IHS’s Grzelak.

“They rely too much on short-term funding from foreign
banks,” Grzelak said of Turkish banks. “So loss of confidence
could lead to loss of that funding very quickly, like last time.
Recalling the role state banks played in that crisis, it
wouldn’t be surprising to see them leading the way once again.”